Foreign Exchange

Overview

Businesses that trade internationally are likely to be exposed to foreign exchange risk arising from volatility in the currency markets. If not managed effectively, the impact that exchange rate fluctuations can have on a business’s profitability can be significant. Nedbank has a team of foreign exchange specialists who can provide all the practical support and discerning advice to make managing currency risk simple and cost-effective.

We will work with you to develop an appropriate foreign exchange risk management strategy that effectively meets the requirements of your business, using instruments such as spot cover, forward exchange contracts (FECs) and derivative instruments.

We provide the following key services:

Spot cover – This refers to foreign exchange transactions where one currency is bought or sold against payment in another currency, at a specified rate, with settlement taking place two business days later. The two-day settlement process, commonly referred to as spot, is international practice and is due to differences in time zones and the time required by banks to ensure that settlement occurs correctly.

Same-day and next-day value deals – Where urgent currency payments or receipts need to be processed, one-day value or even same-day value exchange rates may be provided, depending on the currency cutoff times.

FECs – These are used to hedge exposures to exchange rate fluctuations by ‘locking in’ future foreign exchange rates. FECs are contractual agreements between the bank and its clients to exchange a specified amount of one foreign currency for another at a predetermined exchange rate on a specified future date. There are various types of FECs that can be used depending on the client’s requirements:

A fixed FEC can be used only on the specified maturity date.

A partly optional FEC can be used within a prespecified period between two future dates.

A fully optional FEC can be used at any time between the date of establishing the FEC and the specified maturity date.

Swaps – A swap is the simultaneous purchase and sale of identical amounts of one foreign currency for another, but on two different value dates, either spot against a forward date, or one forward date against another forward date.

Early delivery (or pre-takeup) swaps are used to bring forward the maturity date of an existing FEC.

Extension (or rollover) swaps are used to extend the maturity date of an existing FEC to a later date.

Long-dated forwards – These are FECs with a maturity date longer than 12 months forward.

Currency derivatives – These can also be used to hedge exposure to exchange rate fluctuations, but are fundamentally different from FECs. Whereas the parties to a FEC are ‘locked-in’ to a future transaction in a forward contract, the buyer of an option contract has the right, but not the obligation, to buy or sell a fixed amount of currency at a fixed exchange rate on a predetermined date in the future. The option holder (buyer) can therefore choose the better exchange rate – either the prevailing rate in the market at the time, or the price specified in the option contract. There are two main types of option contracts, namely call options and put options, and these can be used in various combinations to provide structured solutions to meet a client’s hedging requirements. While currency derivatives provide greater flexibility as a hedging instrument, they also have a cost in the form of a premium that is payable at the time of purchasing the option contract. With a call option the buyer has the right, but not the obligation, to buy the underlying currency at a fixed exchange rate on a predetermined future date. With a put option the buyer has the right, but not the obligation, to sell the underlying currency at a fixed exchange rate on a predetermined future date.

Currency futures – A currency futures (CFs) contract is an agreement that gives the buyer the right to buy or sell an underlying currency at a fixed exchange rate at a specified date in the future. One party to the agreement agrees to buy the CF contract at a specified exchange rate and the other agrees to sell it at the expiry date. The underlying instrument of a CFs contract is the rate of exchange between one unit of foreign currency and the South African rand. Contracts are cash-settled in rand and no physical delivery of the foreign currency takes place. CF contracts are traded on the JSE and have margin requirements that the client must provide.